An Unsustainable Path
The recent sovereign debt crises in Greece and other highly-indebted European countries provide a cautionary tale of the rough justice of the marketplace – lenders cannot and will not finance unsustainable deficits forever, and when they cut up the credit cards of profligate countries, severe economic turmoil ensues.
Over the past few years, Americans have seen just how quickly a severe financial crisis can create widespread pain and chaos. But the last crisis was foreseen only by a small number of perceptive individuals who recognized the implications of unwise decisions being made in Washington and on Wall Street.
By contrast, nearly every fiscal expert and advisor in Washington has warned that a major debt crisis is inevitable if the U.S. government remains on its current unsustainable path. The government’s failure to prevent this completely preventable crisis would rank among history’s most infamous episodes of political malpractice.
Nearing a Debt Crisis
Like a household or business, a nation’s indebtedness is best understood in terms of how much it owes relative to how much it makes. By that measure, debt held by the public – money that the U.S. government owes to others – will reach nearly 70 percent of the entire U.S. economy this year.
If this were merely a temporary rise in the debt, it would not be so alarming. However, the spending spree of the last two years, combined with the coming retirement of nearly 80 million baby boomers, threaten to turn these recent deficit spikes into a permanent plunge into debt.
Debt in excess of 60 percent of the economy is not sustainable for an extended period of time. That is bad news for the United States. According to the non-partisan CBO, the President’s budget would keep the debt climbing as a share of the economy in the decade ahead, from nearly 70 percent this year to over 87 percent of the U.S. economy by 2021. University of Maryland economist Carmen Reinhart testified before the House Budget Committee that 90 percent is often a trigger point for economic decline.
How a Debt Crisis Would Unfold
Spiraling interest rates
The first sign that a debt crisis has arrived is that bond investors lose confidence in a government’s ability to pay its debts – and by that point, it is usually too late to avoid severe disruption and economic pain. Right now, the U.S. government is able to borrow at historically low rates, partly because of the Fed’s interventions in the market, but also because the bonds of most foreign countries are looking even riskier. Neither of these conditions is going to last.
Interest rates – and the burden of paying interest on the debt – have nowhere to go but up. Interest payments are already consuming around 10 cents of every tax dollar. But as interest rates rise from their current historically low levels and debt continues to mount, interest payments are projected to consume over 20 percent of all tax revenue by 2020. That means that one in five tax dollars will be dedicated to making interest payments by the end of the decade – and that’s according to optimistic projections about interest rates. If interest rates increase by a higher-than- expected amount in future – which appears to be more likely – then the nation’s interest payments could cost trillions of dollars more.
